The Space Game

How to make room for growing OTP category amid space limitations, contract demands.

This is how David Bishop, managing partner of Bar­rington, Ill.-based Balvor LLC, described OTP during a tobacco panel he hosted at last year’s NACS Show.

It’s an apt moniker: Although OTP has not experienced a rapid or dramatic rise, the category has delivered steady growth over the past decade. During his appear­ance at the NACS Show, Bishop cited a 3.3- point share gain in tobacco sales dollars and a threefold increase in gross margin dollars (a 10.6 point gain) from 2002 to 2011. And Nielsen reported OTP sales in U.S. convenience stores in 2011 rose 3.7% and volume rose 3.3%.

“I think we’ve seen an increase, not only in product, but in profit, in mar­gins, in availability throughout the country,” says Dennis Williams, national accounts manager of OTP for wholesaler Harold Levinson Associates, Farming­dale, N.Y.

So the good news is that taken as a slate, moist smokeless, cigars and roll-your-own are on the rise. That, how­ever, when coupled with the nascent oral segment and cigarettes, tobacco’s powerhouse, creates some challenges for retailers. Specifically, how much space should OTP represent in a retailer’s tobacco set, and which brands should own the lion’s share of facings?

With cigarettes still dominating tobacco sales, how can you optimize OTP in an already cramped backbar? And, as Altria and Reynolds further extend their reach into OTP, will they enforce space-restrictive cigarette-like contracts on competing brands?

While there’s obviously no single strategy that can be universally applied, looking at the practices of retailers and wholesalers such as Harold Levinson can help tobacco purveyors sort out the chal­lenges of the OTP space game.

Margin and Demand

Most retailers readily acknowledge OTP’s importance over the past decade.

“How important are non-cigarette tobacco products to my business?” rhe­torically asks Andrea Myers, president of retailer Kocolene Marketing LLC. “Very—and they’re becoming more and more important as time goes on.”

Martha Flint, who serves as the cat­egory manager for the 226 locations of Houston-based Timewise Food Stores, agrees, describing OTP as “extremely important.” A key reason for both opera­tors is OTP’s appealing profit margins.

“The difference in margin is some­times double digits,” says Myers, whose company operates 38 stores in Indi­ana and Kentucky. “It’s going to differ between first-tier and fourth-tier ciga­rettes, but still, I would say more often than not, it’s a double-digit difference.”

Why the margin gap? “The profit margins on OTP are higher than ciga­rettes for the simple fact that [cigarettes] have certain limitations either from local ordinances or from manufacturers on what you can charge,” Williams says. “That doesn’t really exist in the OTP category.”

Obviously, margins alone are hardly captivating; lots of products boast retail-friendly margins, yet they still fail. Fortu­nately, this has not been the case with OTP, which has seen an increase in consumer awareness and demand in recent years.

“As the cigarette consumer has declined, it doesn’t necessarily mean that the tobacco consumer has declined,” says Williams. “You have a tremendous amount of growth in the OTP category, while you’ve had a decline in the cigarette category.”

Myers also has observed the shift, and she points out that stricter taxes and reg­ulations on cigarettes have driven many of her consumers to consider options they might have overlooked in the past.

“The demand is there,” she says. “Smokers’ minds are becoming a little more open as they can’t smoke in more and more places. They’re more open to trying smokeless, whether it’s snuff or snus or the electronic route. That’s defi­nitely changed.”

Moreover, she says, “The customers are a lot more knowledgeable about OTP, electronic cigarettes and roll-your-own than they used to be.

“It used to be something you had to explain, but they’re pretty knowledgeable now,” she continues. “If you just carry [a small variety of OTP], they’re already educated, they already buy it and they’ll pick it up at your store even if you aren’t as aggressively priced because you’re open when they need it. You have a little bit of an advantage.”

Backbar Battle

Because of appealing margins and demand, many retailers have been shift­ing tobacco sets to make room for OTP— often at the expense of the still dominant but less profitable cigarette segment.

In some cases, the shifts have been drastic, with space dedicated to OTP doubling over a short period of time. “Our current OTP sets occupy an average of 40% of total nicotine category space, compared to 20% five years ago,” Flint says of her Timewise locations.

In other cases, retailers have given OTP as much space as cigarettes—if not more.

“In our c-stores, I’d say it’s about half and half now,” says Myers, pointing out that Kocolene also operates tobacco shops. “We have the new blu e-cigarette rack and 3 to 4 feet of cigars, and in more than half of our convenience stores we’ve added an 8-foot rack of roll-your-own.”

Such moves are not without risks: OTP is not going to surpass cigarettes any time soon. Balvor’s most recent 2012 numbers put OTP at about 10% of all convenience-store tobacco sales vs. more than 30% for cigarettes, leaving retailers on the fine line of investing in their OTP sets without compromising their cigarette core.

This balance could become trickier should the FDA regulate where cigars, smokeless and e-cigs can be sold. If retail­ers are forced to sell all tobacco products behind the counter (as has already been mandated by several states), many may find themselves out of room.

“In some of our c-stores, the cigars are still out on the sales floor. You’re not try­ ing to fit cigars and snuff all in one rack behind the counter with that space,” says Myers. Most of Kocolene’s stores were built in the ’80s and ’90s and average 2,500 square feet. “I would love to snap my fingers and have a few hundred more square feet behind the counter, but we just don’t have the space.”

However, as a wholesaler who works with retailers to build OTP sets all over the country, Williams knows firsthand that an abundance of space is not a pre­requisite for a successful OTP business. The keys are fielding the right assortment and properly merchandising it.

“The best ones that I’ve seen is when [retailers] have a broad-based product mix, encompassing all the aspects of the category as a whole,” he says. “We can incorporate a 4-foot set to include everything from smokeless to e-cigs to roll-your-own/make-your-own, the bagged pipe tobacco to domestic cigars and premium cigars, from accessories to little cigars. What you need is anywhere from 2 to 4 feet of space, and you can make a really nice set where you market the products appropriately and give your retail consumer a lot of choices in the category.”

With space and demand varying by store, it’s rarely a one-set-fits-all scenario. In return for the higher margins, retailers must carefully adjust and monitor their OTP sets accordingly.

“The store demographics play a vital key in determining space allotment and product offerings,” says Flint. “We have continued to improve shelving fixtures in many stores to better present the products and build sales through increased visibility.”

Such efforts, says Williams, are not much different than what retailers are already doing with non-tobacco catego­ries such as beer, snacks or candy.

“[The key is] having a set that’s broad-based and figured appropriately, no different than you would merchan­dise any other category of your store,” he says. “Yet we often find that the OTP set is a mess because of space limitations behind the counter.”

Contracting Sales

If space limitations weren’t enough, as some of the major tobacco companies increase their foothold on the OTP busi­ness, retailers also have to worry about the prospect of cigarette-like contracts on their OTP business—ones that would make it difficult to offer the ever-chang­ing variety of products modern consum­ers desire.

It’s not something that has caused retailers much trouble—yet. With Altria, Reynolds and Lorillard all looking to non-cigarette products to grow their business, retailers fear stricter contracts are not far behind. “With Lorillard getting into the electronic cigarette game and only having a 1-foot rack, it’s been a challenge fitting all of our brands of electronic cigarettes,” says Myers. “I think it’s going to get tougher and tougher. It is and should be a concern to someone in my position.”

Williams is less concerned, believing that manufacturers will keep cigarette and OTP contracts separate, as Altria has done with UST and John Middleton. In fact, he believes that power players invest­ing in OTP will ultimately benefit the category.

“If anything, it legitimizes the category even more, especially on e-cigs,” Williams says. “They are really different types of products: Other tobacco products are not cigarettes. It’s a different approach for that consumer.”

Whether or not stricter contracts encroach on OTP, the very presence of major tobacco manufacturers in the OTP business means the category will change.

“As the big tobacco companies have gotten into the snuff game, the electronic-cigarette game, the cigar game, they man­date things more than it used to be,” says Myers. “It’s doable. It’s not enjoyable, but it’s doable. It’s a constant battle.”

“Are we concerned about OTP con­tracts? Yes,” says Flint. “But our strategy will remain the same: focusing on what is best for our customers and our company. In the end, a happy customer will return, leading to consistent sales and more opportunity for growth.”